The situation in the US bond market indicates the approaching economic crisis

The US stock market is approaching record highs. But one of the most well-known indicators in the bond market suggests that in about a year the United States will face a new economic recession.

Фото: Depositphotos

The yield curve, which tracks the difference between 10-year and short-term rates, has narrowed to levels not seen since August 2007. The 10-year yield is currently 2,98%, just 0,36% higher than the 2-year Treasury yield of 2,62%. Time.

Reducing the difference between these indicators can be a big challenge. As a result, the yield curve may invert, meaning the rate on two-year bonds will exceed the rate on long-term bonds. An inverted yield curve is a common precursor to economic recessions in the United States. The Federal Reserve Bank of Cleveland found that on average, a recession occurs about a year after the yield curve inverts, a rate that preceded the last seven recessions in the country.

What does this mean for the bond market?

With a healthy economic situation, long-term bonds give a higher yield, since investors require additional compensation in exchange for leaving their money in bonds for longer periods of time, that is, they actually lose access to them for a longer time.

Today, the rates of return are rather high and look tempting for investors, however, it is worth considering that, as a rule, during a recession, interest rates fall, as a weak business environment means less competition for borrowed money, and funds invested in bonds are just a loan for business. .

What does this mean for the stock market

The yield curves have become very close, suggesting that economic growth will soon slow down, but the inversion has not happened yet.

Recent research from BMO Capital Markets has shown that during periods when the difference between 10-year and 2-year bond yields narrowed to less than 0,5%—without inversion—stock markets tended to do well.

It is also important to remember that if the yield curve is inverted, then it usually happens more than a year before the recession occurs, therefore the decline in the stock market will occur, if it happens at all in the coming years, not so soon.

What should you do

While the inverted yield curve predicted the last seven recessions, there were two cases in which inversion did not lead to subsequent crises.

In 1968, the yield curve reversed, but no recession followed. And in 1998, the inversion lasted only a month, and no recession followed. But the curve invested again after eight months, which ultimately led to a large-scale crisis.

At the moment there is no guarantee that the yield curve will soon be inverted.

Therefore, instead of worrying about the possibility of a recession, check the risk level of your investment portfolio. Make sure the ratio between stocks and bonds is at a safe level. For example, in 2008, during a financial crisis, a portfolio of 90% shares and 10% bonds would lose 33%, while a portfolio with 50 divided into 50 would lose only 16%.

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